What Does KYC Mean For Crypto?

What Is the Objective of a Know Your Customer Program?

The overarching goal of Know Your Customer (KYC) rules is to discern, with a high degree of confidence, that customers are who they say they are. The KYC process helps to identify and prevent money laundering, terrorist financing, and fraud, and works in concert with Anti-Money Laundering (AML) regulations.

Why Is Know Your Customer Important?

Know Your Customer and related AML regulations can benefit both financial institutions and their users. These rules mitigate risk, improve security, protect institutional integrity, and keep bad actors off the books. In turn, regulators are satisfied and customers can feel reassured and more trusting of the companies they do business with. If used effectively, KYC can also help to replace obsolete verification systems, perform necessary services — like screening and registering new users — and make sure that high-profile transactions are fully compliant.

The History of Know Your Customer

For decades, the U.S. government has had regulations in place asking financial services companies to help them detect and prevent financial crimes. In 2001, as part of the USA PATRIOT Act, the United States Department of the Treasury detailed specific KYC processes that financial services firms must have in place, and in 2016, the Treasury elaborated on and applied these regulations to the FinTech sector. In 2013, the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) published interpretive guidance FIN-2013-G001 that declared that administrators or exchangers of virtual currency are money services businesses under the Bank Secrecy Act and FinCEN regulations. Money services businesses are subject to the AML and KYC requirements of the Bank Secrecy Act.

So, What Is KYC?

AML regulations usually leave the specifics of the KYC process up to the regulated entities, using a risk-based determination of what rules are appropriate. These KYC programs generally include the following three basic components:

1. Customer Identification Program (CIP): As part of a CIP, a firm identifies a potential customer and verifies the customer’s identity via reliable and independent data. The specific features and documents that need verification vary depending on the local jurisdiction. At a minimum, a firm gathers a client’s name, date of birth, and address. Other possible data could include social security number, driver license, and passport. Some firms require videos or selfies as part of their identity verification, and others provide customers with a Know Your Customer form or template as the first step in verifying their identity.

2. Customer Due Diligence (CDD): This type of due diligence is essentially a thorough background check of a prospective client. CDD seeks to understand any risk that a new customer potentially could bring to a business and exposes fraudulent behavior. If warranted, some companies will use an enhanced due diligence (EDD) process, which is simply a deeper dive into assessing a potential customer’s risk level. EDD procedures are usually conducted manually by trained compliance officers, and they can be extremely rigorous depending on the person being vetted and the financial institution’s desire for subjectivity.

3. Ongoing Monitoring/Risk Management: Sometimes firms separate ongoing monitoring and risk management, with risk management becoming a fourth step. But, essentially they serve the same purpose: to nip any suspicious behavior in the bud, a financial services company must continue to oversee its customers and their transactions thoroughly and consistently, paying particular attention to large or unusual transactions.

Know Your Customer and Cryptocurrency

Because the crypto industry is still relatively new, crypto regulations are also relatively new and still developing both with respect to their comprehensiveness and where and how they are applied. Depending on their location, business principles, and licensing regimes, crypto exchanges conduct varying levels of Know Your Customer programs. Some allow users to register an account without conducting a thorough KYC process, albeit with very limited functionality. These exchanges run the risk of regulatory noncompliance. Others allow onboarding of new customers with an uploaded photo ID, but with only a fixed small deposit and withdrawal limit. Crypto exchanges that want to permit the deposit, withdrawal, and transmission of large amounts of crypto, however, almost always need to vet their customers through a more comprehensive Know Your Customer verification process.

The information contained in this article is for informational purposes only and should not be construed as legal or any other advice.